Why China, Ukraine probably won’t derail markets

WilliamL. Watts

Reuters

Protesters in Kiev set up barricades as vehicles burn nearby.

NEW YORK (MarketWatch) — Deadly turmoil in Ukraine means trouble for the Eastern European nation’s struggling economy and, potentially, its neighbors, while another sign of Chinese manufacturing contraction rattled global stocks Thursday, but events in those countries are unlikely to trigger a repeat of a January swoon in emerging markets that precipitated a pullback by U.S. stocks and other developed markets.

Ukraine’s capital, Kiev, saw bloodshed Thursday, marking the violent end to a truce between the government and demonstrators. Protesters were targeted by snipers and automatic-weapons fire after breaking through police lines and marching toward Parliament, according to a Wall Street Journal report.

Reuters

Protesters use a slingshot to fire objects toward Interior Ministry forces and riot police in Kiev on Tuesday.

Ukraine’s health ministry put the casualty toll since violence first erupted on Tuesday at 67 dead and 562 wounded, the Journal reported.

Shocking photos of the fighting in Kiev ran across many news organizations’ home pages on Thursday and sent Eastern European currencies lower — an echo of the drop in Turkish and emerging-markets currencies earlier this month that helped drive the S&P 500
SPX, -0.23%
to a 6% fall from its recent highs.

Global stocks, however, were more attuned Thursday to China, where a preliminary February purchasing for the manufacturing sector sank further into contraction mode.

Asian and European markets swooned in reaction to the China data. U.S. stocks also were headed for a weaker open but soon shrugged it off to push the S&P 500 SPX, -0.23%
within spitting distance of its all-time high after an upbeat take on U.S. manufacturing and other data.

Kathleen Brooks, research director at Forex.com, was among analysts playing down the China concerns, noting that overall data reports have been relatively upbeat in recent weeks and wondering if the Lunar New Year had also played a role in depressing activity.

Meanwhile, the reaction in emerging-market currencies was mixed in the wake of the data, with events in Ukraine having more of impact on emerging European currencies, while the Turkish lira, whose January dive to a record low helped spark global market jitters, gained some ground, she noted.

But U.S. market bulls shouldn’t get too comfy. In the end, that might simply mean that developed markets will take a cue directly from China rather than from how emerging markets react to the China data, Brooks said.

The cost of insuring Ukraine government debt against default using instruments known as credit default swaps has jumped since early February. It cost the equivalent of an eye-watering $1.023 million annually on Feb. 4 to insure $10 million of Ukraine government debt against default, rising to $1.325 million by Feb. 19. The cost eased back to $1.305 million on Thursday, according to data provider Markit. Ukraine bonds and stocks rallied on hopes that sanctions by the European Union would prompt President Viktor Yanukovych to end the violence, Bloomberg reported.

The Ukraine currency, the hryvnia, has seen renewed weakness. The currency
USDUAH, +0.0000%
traded at more than 9 per U.S. dollar on Wednesday and changed hands at 8.905 per dollar on Thursday. The U.S. currency has gained 8.5% on the hryvnia since the beginning of the year, while the euro’s risen 7.8% over the same stretch, according to FactSet.

Make no mistake, there is a “high risk” of default on Ukraine assets, said Regis Chatellier, emerging-markets strategist at Société Générale, in a note.

Moreover, any scenario in which default is avoided — say, by a quick injection of aid from the European Union — would still result in a big hit to the country’s economy, he said. That is because such a move would be almost certain to trigger retaliation from Russia in the form of sanctions.

In the end, a default would be “significant, but not systemic,” Chatellier wrote, noting that Ukrainian bonds represent around 3% of the main credit indexes, which means a default could be absorbed by the market.

That still means, however, that a short-term wave of “risk-off and suspicion towards emerging markets would be likely,” Chatellier said.

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